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The Dismal Science

IN ECONOMICS no bad idea goes unused. This is perhaps to be expected in a discipline that prides itself on being the science of the efficient allocation of scarce resources. Ideas are hard to come by in the best of times. With many hundreds of doctoral candidates looking for original dissertation subjects, and many thousands of tenure-track assistant professors looking for profound article topics, nothing that looks like an idea can be allowed to waste its fragrance on the desert air. In addition, there are the diurnal needs of business-page journalists and bond salesmen. Not to mention the problems of NEW LEADER columnists.

A subject that has met all the above needs for at least the past quarter century is the productivity index. It is with mixed feelings that I report on a quite new use that has been thought up for this fallacious procedure. Since, as we shall see, the new use is in the very highest reaches of national policymaking, it is in an especially bad place for a bad idea.

The February 8, 1982, column in this space was titled “Productivity: The New Shell Game.” On May 28, 1984, “The Productivity Scam” appeared. The third antiproductivity- index piece had to wait until May 19, 1993, and the fourth is here and now. Productivity being a protean idea, each column is concerned with a different use of the index.

True to its metaphor of a shell game, the earliest column said that in the new game each of the three shells had a “pea” under it. The first pea, “which always turns up on metropolitan bars and suburban bridge tables,” was that “it just seems people aren’t willing to work the way we did when we were young.”

Next was the “America has gone soft pea.” We let them beat us in Vietnam; investigative journalism got out of hand over Watergate; and now a court has said that creationism isn’t science. It’s hard to tell what the country stands for anymore. It’s no wonder that productivity is down and we have to have this recession to get us back on the track.

Under the third shell was the “archaic industry pea.” Our productivity is down because we don’t invest enough, because we don’t save enough, because we tax business-too much.

In other words, the productivity “peas” were Reaganomic explanations of the recession then stagnating. Regardless of the shell we chose, we got a pea; and regardless of the pea we got, we lost.

By May 1984, the productivity focus had narrowed, with this conclusion: “The uproar about labor productivity is a scam to distract attention from a massive shift in the distribution of the goods of the economy. The share of nonmanagerial labor is being reduced; the share of managerial labor is being increased; and the share of those who do no labor, who merely have money, is being increased most of all. This is what Reaganomics (or, if you will, Volckerism) is all about, and the Atari Democrats have been gulled into going along with it.”

(Those whom the late Robert Lekachman, a wise and witty contributor to this journal, dubbed Atari Democrats called themselves New Democrats. Atari was at one time the leading producer of electronic games, and was early seduced abroad by the promise of cheap labor. What became of it, deponent knoweth not.)

Nine years later (May 19, 1993), the focus had narrowed again. The talk was all about downsizing, a nasty and disgraceful business practice that continues to this day.

The productivity index is thus one of the most powerful ideas of our time. It has malignly affected the lives of millions of men and women, the fortunes of thousands of enterprises, and the economies of nations. It is a tragedy of almost universal scope.

The basic idea of the index is sound enough. Output is divided by input to determine how many units of input achieve a unit of output. The result is an index number that can be compared with other numbers similarly derived. A single index number, of course, is almost useless; but much can be learned from comparisons, and they are of great and daily use in business management. The current performance of a company’s sales (or any other) department can be compared with. its performance in prior years, or with the performance of corresponding departments of the particular industry as a whole. Banks routinely analyze their customers’ profit and loss statements in this way, and trade associations frequently do the same for their members.

It must be confessed that executives sometimes make unreasonable use of the comparisons. A sales department may be faulted for a falling sales index, while the sales force argues that the quality of the product has declined, or that the advertising has been inadequate, or that the sales representative suffer from stress caused by driving poorly equipped automobiles.

Rumbles from the executive floor suggest that the sales reps are too well paid, or that there are too many of them, or that some territories are not worth covering. This is the way that downsizing begins. Every job in every department is ultimately at risk.

Years ago a chapter in a tome on book publishing started this way: “There are two simple principles by which the business thinking of a publishing house should be guided. They are (1) Reducing costs by $1,000 has roughly the same effect on the profit and loss statement as increasing sales by $25,000. (2) You have to spend a dollar to make a dollar.

Downsizing tends to forget the second principle, and also the greater principle that the human beings who are so easily hired and fired are not a means to an end but are ends in themselves. But the ethical objections to downsizing shouldn’t allow us to decide that there are not solid, hard-nosed, business-is-the-only-thing objections to the national productivity index.

THE INDEX numbers are simple fractions: national output for a certain period in dollars (because we can’t add shoes and ships and sealing wax) divided by the hours worked by everyone engaged in production, whether paid or not. Fractions, of course, are not unequivocal; you can increase their value either by increasing the nominator or by decreasing the denominator (2/3 and 1/2 are both greater than 1/3). So you can increase a productivity index number either by increasing “dollars of output” or by decreasing “hours worked.” As we shall see, the hours present a special problem. Consider some examples of how the index works.

First, microeconomically: Think of a journeyman plumber whose output is x, whose hours worked is y, and whose productivity is therefore x/y. Suppose by taking on a plumber’s helper (a human being) he increases his output 20 per cent. Being a rational person, you might conclude that such an increase in output would result in a substantial increase in productivity, but you would be sadly mistaken. According to the formula, his productivity becomes 1.2x/2.0y, or .6x/y, and thus has fallen 40 percent.

We get similar results macroeconomically. Take the 5.4 million or so people counted by the Bureau of Labor Statistics as unemployed. (There are about 10 million more who aren’t counted because they have a part-time job, or are too discouraged to continue looking for work, or are too turned off ever to have seriously entertained lawful employment).

Let’s accept (for argument only) that the conservative press is correct in saying the 4 percent of our civilian workforce officially designated unemployed are so careless, stupid, uneducated, arrogant, sickly or pregnant that they’re unlikely, if employed, to produce on the average more than a third as much as an equal number of those who are currently employed. Even at that level, if we could find the wit and will to employ these people on this basis, we could increase our gross domestic product by 1.2 percent, or about $130 billion a year.

Being still a rational person, you might think such a tidy sum would increase our productivity, but again you would be sadly mistaken. Productivity is still output divided by hours worked or x/y. After finding jobs for the 4 percent of our civilian workforce that is now unemployed, our productivity becomes 1.012x/1.04y, a fall of 2.7 percent.

So if we really believe in the conventional theory of productivity, we must deny help to our plumber and jobs to the unemployed. Unfortunately, a large majority of the members of the American Economic Association do believe in the theory.

A couple of other examples may clinch the case.

A young slugger lived up to his promise by hitting a grand slam home run his first time at bat in the majors. His next time up, there were only two men on base. His manager yanked him because (aside from drawing a walk or being hit by a pitch, neither of which would count as a time at bat) his productivity could only go down.

Then there was the unsung predecessor of Tiger Woods who hit a hole in one on the first hole of a club tournament, but retired when his drive on the second hole stopped rolling two feet short of the cup. “My productivity could only go down,” he lamented as he gave his clubs to his caddy and took up water polo to sublimate his aggressions[1].

THE THING about “hours worked” is that Gertrude Stein couldn’t have said “hour is an hour is an hour” because they aren’t. I was a lousy salesman, though I worked doggedly at it for almost five unproductive and depressing years. Many years later I became a moderately successful CEO of a small company and worked doggedly at that. I put in approximately the same number of hours a day as a salesman as I did as a CEO. After all, there are only so many hours in a day. But the value of my work as CEO really and truly was vastly greater than the value of my salesmanship, and you may believe I was paid more for it, too. Adding those different hours together in the denominator is less sensible than adding apples and oranges.

Karl Marx[2] faced a similar problem when he was wrestling with his theory of surplus value. He finally declared victory and wrote: “We therefore save ourselves a superfluous operation, and simplify our analysis, by the assumption, that the labor of the workman employed by the capitalist is unskilled average labor.” If this was a valid assumption in his day (and it probably wasn’t), it certainly is not in ours.

John Maynard Keynes also felt a need to devise a homogeneous unit of labor. He wrote: “Insofar as different grades and kinds of labor and salaried assistance enjoy a more or less fixed relative remuneration, the quantity of employment can be sufficiently defined for our purpose by taking an hour’s employment of ordinary labor as our unit and weighting an hour’s employment of special labor in proportion to its remuneration, i.e., an hour of special labor remunerated at double ordinary rates will count as two units.”

The minimum wage (currently $5.15 an hour) may be taken as a homogeneous unit of labor. But why bother? It is merely a multiple of a homogeneous unit we already had ($1.00) and tells us nothing new.

Unless you naturally think like an economist, you may wonder why the denominator of the productivity fraction is “hours worked” rather than “dollars paid for labor.” The deep secret is that economists, like well-bred characters in an early 19th-century English novel, are with a few exceptions embarrassed by talk about money. General equilibrium analysis, the most fashionable economic theory at the bulk of elite American universities, can find no place for money in its doctrine. Even monetarism, despite its name, is scornful of the stuff we pay our bills with, which it speaks of as “nominal” money, and insists that what it calls “real” money is what matters, although no such thing exists. (If you’ve read much medieval philosophy, you may find such talk familiar.)

There is another problem with the denominator. We learned in school that the factors of production are land, labor and capital. Some add technology, and Adam Smith wrote of a propensity to barter. In any case, labor is merely one of the factors of production; yet the productivity index treats it as the only one.

To be sure, labor may be the largest factor. A quasi-constant of the economy is that the cost of labor currently runs about 60 per cent of GDP. But the cost of capital-the money spent for interest by nonfinancial, nonagricultural businesses -has increased roughly five and a half times in the past 40 years, partly because the Federal Reserve has increased interest rates, and partly because today American business relies much more on borrowed money than it used to. Common laborers, not Protestant financiers, are now the austere actors on our economic stage[3].

This shift in roles may be good or bad or indifferent, but the productivity index, no matter how constructed, will at best only call our attention to the fact that a shift has occurred. It will neither judge the desirability of the shift nor tell us what to do about it. Econometrics-c-playing with statistics-is the beginning, not the end, of economics.

ALL THAT said, we come to the new use of the productivity index mentioned at the start. I’m sorry, but I can’t say who invented the new use. It was a stroke of genius, even though the Federal Reserve Board had already pioneered the implausible idea of using high productivity (according to the index) as an excuse for trying to reduce production. I’m sorry again, but I can’t say, at least with a straight face, why we should reduce production.

The new scheme goes like this: (1) Production is produced by workers exercising their productivity. (2) The population of workers increases about 1 per cent a year. (3) The productivity index, fallacies and errors and all, increases about 1.5 per cent a year. (4) Put them together, and you get 2.5 per cent a year as the rate at which a well-mannered economy should expand. (5) The economy has been expanding at better than that rate in every year except one in the last eight. (The low one was 2.4 per cent in 1993.) Conclusion: Look out! It must be overheating!

Well, I ask you!

I regret to have to add that the Democratic Party Platform Committee listened solemnly to this kind of stuff. I doubt that the Republicans bothered their heads about it. All they need to know on earth is that a tax cut is beauty, and beauty is a tax cut, especially a tax cut for millionaires. I regret further to have to admit that the economics profession is careless about such nonsense. The other day I read a paper by a friend of mine that was decorated by several equations in which a symbol for productivity occurred. I objected that the symbol stood for a fallacy, and that his equations were therefore fallacious.

He laughed. “Everybody does it,” he said. “You’re expected to do it. It doesn’t matter.”

Well, I’ve already asked you.

The New Leader

[1] Ed: As a similar tale goes, a golfer played at Pine Valley, arguably the best golf course on earth, and in the first four holes had two birdies and two eagles. One eagle was a hole-in-one. He was 6 under par. The fourth green is back at the club house. The golfer walked off the course and into the bar and would not come out as he’d only screw up the round.

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TWO YEARS AGO, the hope was expressed here that the Federal Reserve Board was on the verge of learning how a modem capitalist economy-call it “the New Economy” if you wish-actually works, or could work (“A Fortunate Experiment,” NL, August 10-24, 1998). But it has become clear that the Reserve was merely adopting another new theory of how a quasi-mercantilist economy functions at least the fifth in Chairman Alan Greenspan‘s incumbency.

The previous new theory of the old economy went like this: Exuberant stock markets are giving rise to a “wealth effect,” whereby wildly successful speculators are using their inflated capital gains as collateral for loans to buy second (or first) homes and automobiles and a variety of other items, some necessary and some simply nice to have. As a result, the economy is in danger of “overheating.”

Now here comes what they call in Silicon Valley the new new thing: The secret cause of our trouble is that our productivity is growing too fast (the year before last it was supposed to be growing too slowly); consequently, the wealth effect is higher than ever. Indeed, it is so great that people’s income from borrowing on their capital gains exceeds their income from working at productive jobs. This situation is said to be unbalanced and unsustainable. We are borrowing on the future,” “living beyond our means,” and violating other 18th century copybook maxims.

Yet that is exactly the virtue of modern capitalism. It is how the company I worked for could expand to give me a better job, how my wife and I could buy a decent home in which to raise our children, how the city could build schools to educate them, and not least, how World War II could be won.

It is also argued that the wealth effect will cause too much money to chase after too few goods, a.k.a. inflation. A moderately rational person might consider encouraging the production of more goods wiser in such circumstances than reducing the amount of available money. The answer to this suggestion is that to produce more goods we would have to hire more people; and since we pride ourselves on having practically full employment (so why not say it’s really full?), we can’t hire more people without starting a wage-price spiral. To be sure, we have some 20 million fellow citizens who are either unemployed, underemployed, uninterested in employment at the going wage, or turned off.

Because of (not in spite of) the Federal Reserve Board’s threat to resume increasing the Federal funds rate, the United States economy is on the launching pad for an interest-price spiral (not a wage-price spiral) that could start spinning tightly upward before the 2000 election and then, before the election of 2004, could collapse in the ninth recession since the end of World War II.

In It Can’t Happen Here Sinclair Lewis’ hero opined that we Americans might one day have fascism but would call it antifascism. True to this heritage, the Federal Reserve Board has adopted an inflationary policy but tells us (and itself) that it is fighting an inflation invisible to ordinary folk like us because it is around the curve.

PERHAPS not altogether coincidentally, the Reserve acted in the same way almost a third of a century ago, in 1969, the last year we had a budget surplus before the current one. It was also the final year of what is now the economy’s second longest expansion. During the following 14 years we had four recessions, the highest unemployment rates since the Great Depression, a series of sensational bankruptcies, and a record breaking 271.4 per cent surge in the Consumer Price Index. The Reserve was serious about inflation the whole time.

Of course, there was a war on in Vietnam then and (as at present) trouble with the Organization of Petroleum Exporting Countries, but raising the interest rate did not stop the war and in truth started the trouble with OPEC. Meanwhile, the costs of living and doing business went higher, and the budget surplus was wiped out.

Money has power-several powers, in fact, as we shall see. The most familiar is its purchasing power. The Federal Reserve Board, in its diurnal struggle with inflation, has long concentrated on restraining money’s buying power. It does this by increasing the interest rate in order to reduce the number of consumers able to buy interest-sensitive commodities (especially cars and houses). This, in turn, reduces the number of workers employed in supplying those commodities, keeping them from buying other commodities they want or need. All of that is supposed to prevent the economy from overheating.

When we return from a shopping (or web-surfing) expedition and say the dollar doesn’t go as far as it used to, we mean its purchasing power is reduced. That is the same as a rise in the general price level, which is the same-as inflation.

THERE ARE two other probable, but presumably unintended, consequences of the Reserve’s actions. The first is a recession. To rephrase “Engine Charlie” Wilson, what is bad for General Motors is bad for the economy. We can’t slow down on the building trades and the automobile industry and their many auxiliaries (steel, lumber, oil, glass, rubber, major appliances, and on and on) without slowing down the whole show. Second, although the Reserve may have only restraint of purchasing power in mind, raising the interest rate simultaneously reduces the borrowing and investing power of money.

A fall in the investing power of money is, of course, the same as a decline in the amount of investing that is done-in other words, stagnation. Assuming that a projected investment is attractive and that the credit of the company wanting to make it is sound, the interest rate determines the limit of investing the company can finance with a given sum.

The range of impacts on investing power is vast, as four historical examples will show. Before the 1951 “Accord” that “freed” the Federal Reserve Board from its World War II commitment to help the Treasury maintain the market prices (and, of course, the interest rates) of government securities (not an unreasonable chore for a central bank in time of war or peace), the prime rate was 1.5 per cent. In December 1980 and January 1981 the prime topped off at 21.5 percent. In June 1999, at the start of the Reserve’s present program, it stood at 7.75 percent. Now it has reached 9.5 per cent (not so long ago, anything over 6 per cent was illegal usury). A corporation that could afford an annual interest expense of $150,000 and borrow at prime, could therefore have borrowed and invested $10 million in the first example, but only $697,674 in the second example, $1,935,484 a year ago, and $1,598,947 today.

Moreover, the effects of a rise (or fall) in the interest rate multiply throughout the economy. When the prime hit 21.5 per cent around Christmastime 1980 and our company’s investment was limited to $697,674, the purchasing power of every dollar of that amount likewise fell 12 per cent. So the firm could actually purchase only $613,953 worth of goods and services for its investment.

The Reserve’s present program (ironically assisted by OPEC) will increase the cost of doing business and will soon prompt or excuse enough price increases to embolden the many inflation hawks on its Board of Governors to push harder for really pre-emptive strikes, whereupon further price increases will begin appearing on the visible part of the curve, and the interest-price spiral will be well launched.

The increasing prices will harden the inflation hawks’ belief that they “must” (as the business press puts it) raise the interest rate to hold prices down. But a capitalist economy is based on borrowing, and the causation runs from the cost of borrowing (the interest rate) to price, rather than the other way[1]. Every firm, before it starts work on a new project, or orders a new production run of an old one, must know its costs to set prices.

The cost of borrowing is established by the Federal Reserve Board when it determines the Federal funds rate. To be sure, that rate is the one banks charge each other for very short-term loans (usually overnight) to allow the borrowing bank to meet an emergency or to take advantage of an exceptional opportunity, but it also sets the floor under the cost of all borrowing.

Today the nation’s business enterprises routinely quote many millions of prices, change some, and establish thousands of new ones. Scores of millions of consumers agree to some of the prices, and sales are made; a few haggle for lower ones, with occasional success. All of these prices are based in part on what the Reserve did at its last meeting. But there is no way on earth that what the Reserve did at its last meeting could have been based on the prices sellers and buyers actually agree to afterward.

This is not a chicken–and–egg question. Actual prices are based on actual costs, never the other way around. Businesses do not set the floor under interest rates, the Federal Reserve does[2].

In sum, as the Federal Reserve Board continues to raise the interest rate, it will cause stagnation (a decline in investment), stimulate inflation (a rise in the price level), and achieve its perverse intentions (a decrease in demand and an increase in unemployment). It will prick the stock exchanges’ irrational bubbles with consequences that will confirm the wisdom of Marcel Proust, somewhere in whose expansive universe is the observation that our wishes may be fulfilled, on the condition that we not find in them the satisfactions we expected.

IT IS POSSIBLE that the Reserve is already too far in to back out, for to cut rates now would announce to all the Fed watchers that the threat of inflation was past. The bull market would roar ahead, speculators confident that the Reserve would protect them. (Economists call this phenomenon by the odd name of “moral hazard.”)

Yet at the very least stagnation would be avoided if the Reserve did the unimaginable and lowered rates. At the best, new ways might be found to expand the economy and to reverse the fatal trend toward continually widening the chasm between the haves and the have-nots of our society.

Given the Reserve’s blind tradition of “staying the course,” the summer’s growing inflation and stagnation may continue and prove enough to defeat Vice President Gore (as former Reserve Chairman

Let me say next that I’m not impressed, and never have been, with the argument that it’s wrong to oppose child labor in India (a nation that deplores America’s crass commercialism and lack of spirituality) on the grounds that if the children didn’t work, their parents would starve. Arguments of that kind have been used since the beginning of time to justify every conceivable example of man’s inhumanity to children, to women and even to other men. If it is impossible to make rugs of the highest-that is, most traditional-quality unless the knots are tied by juvenile fingers, it would be no hardship for us to walk on broadloom carpets.

I am not, furthermore, abashed by the debater’s point that if I want to protect several million American jobs, I can do so only by throwing several million (and probably more) workers out of work on the other side of the world. The late Sidney Weintraub, a longtime contributor to this magazine, had the answer to that one. He asked whether any free-trade publicist or professor ever felt obligated to resign in favor of a jobless scribbler or savant half a world away. If not, why not?

I am willing to entertain, for purposes of illustration (since I am showing, not arguing), the exceedingly remote possibility that American environmentalists thought up dolphin-safe tuna nets and turtle-safe shrimp nets to interfere with the ability of Central American fishermen to compete with ours. Whether the new nets impede trade or not, though, they certainly promote diversity of life and so, in the general interest, should be required by any responsible authority.

On the other hand, I submit that it is none of our business where France buys its bananas (especially since we don’t grow them). It is preposterous to the point of idiocy that we should have the right, because France insists on buying bananas from its former colonies, to impose tariffs of 100 per cent on brie and foie gras and other delicacies I happen to like-whose producers, to the best of my knowledge, do not now have, and never have had, anything to do with bananas.

All such nonsense, and much more, was foreseen by Ralph Nader, Senator Ernest F. Hollings (D.-S.C.) and others who testified against Congressional approval of the World Trade Organization (the new, friendlier sounding name of GATT, or the General Agreement on Tariffs and Trade). Brief hearings were hastily held over a few days around Thanksgiving in 1994. Unfortunately, it was agreed that the question would go to the floor on a “fast track” basis, with limited debate and no opportunity for amendment: just a simple vote up or down. The whole thing was a done deal by December 8. It would not be outrageous to suggest that few legislators had a detailed understanding of what the WTO was about, although it sounded good, and most citizens did not know how their senators and representatives had voted, let alone why.

The fast track was not an altogether bum idea, for tariffs are even more subject to logrolling than military appropriations. The trouble was, and is, not that the WTO has a few sloppily drafted passages of the sort that are almost unavoidable in any large piece of legislation. No, the trouble is that the World Trade Organization is not merely foolish, but dangerous.

Unhappily, what’s done is not so easy to undo, especially in an organization that was conceived in secrecy, does most of its business in secret ad hoc committees, and can overturn its secretly arrived-at decisions only by a unanimous vote. (A vote of 148-to-nothing is hard to achieve in the best of conditions, and is practically certain to prove impossible when the “ayes” must include both the plaintiff and the defendant.)

As I said at the outset, the best thing the WTO could have done in Seattle was abolish itself and start over. Somewhere on the desk before me I have suggestions for an alternative approach. My idea was designed to protect the interests of workers and consumers in both developed and underdeveloped nations. It first appeared in this column about 18 years ago.[1]

WE BEGIN with the workers in the developed countries, for the WTO is taking away something they once had-namely, reasonably decent jobs. At the least, they had much better jobs than many millions of them have today in this prosperous millennium. Let me repeat two dicta that I hold self-evident: (1) The citizen’s right to make an honorable contribution to the common wealth is equal to the state’s right to hold him or her to its laws. (2) No full-time work that does not support a life of honor and decency is worth doing except as a favor or a hobby, as training or punishment, or in defense of the realm.

No American official-nor any official of any other nation-is entitled to take these dicta lightly. Bearing them in mind, I say the way to protect is to protect directly and openly.

First, we recognize that a few of our important (not necessarily our largest) industries are threatened in their home market by severe competition from foreign industries. Second, we determine whether that competition is made possible by wages or working conditions that we should consider exploitative or dangerous. Third, we simply and absolutely refuse admittance to commodities produced under such conditions. We don’t fiddle with the tariff on foie gras or anything else; we simply forbid the importation of offending stuff.

The proposal is not complicated. It does not cover all industries or any other nation (although we would not object if the possibility helps improve conditions in other countries anywhere in the world). It does not dictate where France buys its bananas. It does not require elaborately contentious cost accounting, as do the WTO rules against “dumping.” It turns on straightforward questions of fact. What are the working conditions? Is child labor employed? What are the wage scales? (And don’t try to kid us that the serfs are happy; it’s our happiness that we are protecting.)

The proposal does not interfere with foreigners’ or multinationals’ trade anywhere else in the world. In every respect it is analogous to laws currently in effect that refuse entry to contaminated foods or drugs we consider dangerous (regardless of what anyone else thinks), or automobiles that do not meet our emissions standards, or books that violate our copyright laws, or foreign-made assault rifles. Such laws protect Americans as consumers and citizens. The proposal will protect Americans as workers and as entrepreneurs.

Some will object that it can’t work, because it is impossible to compare foreign wage scales and working conditions with ours. If the comparisons can’t be made, how do the critics of American workers know they are overpaid? The objection misses the point anyhow. The proposal is not trying to change foreigners’ conditions but to protect ours. The WTO tries to run the world in accordance with an archaic economic dogma. The proposal is intended to protect our right to follow our vision of the good life in our own way.

The crucial question is, as the lawyers say, who has the burden of proof? In the present case, we can reasonably ask those seeking access to our markets to prove that their workers are fairly paid and fairly treated by our standards. As the Wall Street Journal might proclaim, we insist on a level playing field for all our home games. American companies and American unions and even committees of American workers would have the right to challenge the proof. No need to make a big fuss over it, any more than a fuss is now made about determining that certain foreign automobiles do not meet our emissions standards, or that certain drugs are legally inadmissible.

There are many who will argue against protecting the American standard of living. Some will be devoted to consumers. Cheap imports, they will say, benefit everyone. If so, how do we repay those who lose their jobs so that the rest of us can be free to choose among low priced commodities? Or don’t we care?

NOW CONSIDER the situation of the underdeveloped countries and peoples of the globe. Today, as in the 18th and 19th centuries, the more developed countries need the less developed countries as sources of raw materials, some of which are not available elsewhere. The multinational corporations also use certain less developed countries as sources of cheap labor and working conditions. The banks of the First World have found the weak nations of the Third World eager borrowers of money at high interest rates. What was imperialism before independence has become neoimperialism.

The social and political domination of imperialism is largely gone, but the economic extraction of neoimperialism grows and festers. The irony is that what is mainly extracted is labor power. This comes about because the goods the multinationals manufacture in the Third World are sold in the First World. Steel produced by Brazilian mills is bought in markets formerly served by Pittsburgh. Plastic frame irons General Electric manufactures in Singapore are sold in American discount stores. American textbooks printed in Hong Kong are studied in British classrooms. California sports shirts stitched together in China are sold in resorts on the Florida Keys.

As a result of all this activity, the Third World has goods to export, but never seems to have enough. The reason is that the exports to the First World are paid for with imports from the First World. It is at this point that the extraction of labor power shows itself, for many times more labor goes into the exports as into the imports.

The wage differential varies from industry to industry, from country to country, and from time to time, but a rough idea of comparative wage scales can be gathered from the Gross National Product per capita. Today that figure is $2,800 in the Peoples’ Republic of China, $1,350 in Nigeria, and $3,300 in Brazil. In the United States it is about $32,000. On the basis of these figures, we will not be overstating the case if we say that a dollar commands at least five times as much labor in the Third World as it does in the First World.

Thus when the two “worlds” exchange goods, the Third World is the net loser of four-fifths of the labor involved. This four-fifths is extracted and gone forever. The Third World nations will escape from neoimperialism only when they are able to sharply reduce manufacturing things for the First World and increase manufacturing things for trading with one another. For many and obvious reasons, this will not be easy to do. Their situation is only superficially like that, say, of the fledgling United States in the 19th century.

Two differences are crucial. First, although Europe (mainly Britain) invested heavily in the United States, the investments were either in factories for things like sewing thread or pig iron that were largely consumed in the U.S., or for dams, railroads and other infrastructure, which necessarily remained in the U.S. Early on the United States exported agricultural products, but comparatively little else.

Second, the United States was thinly populated, the frontier was open, and the egalitarian tradition was strong; so labor was in great demand, and American wages were the highest in the world (a boast, incidentally, that we can no longer make).

There was, in short, no possibility that Europe might extract American labor power. Any extraction ran the other way. The Third World has been enticed, by faulty economic theory, into producing primarily for export. On such a foundation, they can have little hope of an early escape from neoimperialism.

Providentially they can be helped if we help ourselves. That is to say, they may be nudged into trading among themselves if we reduce our labor-extracting trade with them. It is in our interest to protect ourselves from such trade because it hurts our fellow citizens. The citizens of a nation have, in the grand old phrase, certain rights, privileges and immunities that are denied to foreigners. If we who are citizens are not distinguished in this way from outsiders, of what meaning is citizenship to us? And if national citizenship is without meaning, of what meaning is the nation?

Perhaps we don’t want a nation. Perhaps we reserve our loyalty for those who are very near and very dear to us. Perhaps, as D.H. Lawrence put it in Aaron’s Rod, we “love-whoosh for humanity.” But if we have a nation, then the well-being of our fellow citizens has to be vital to us. We can’t demand respect for our own well-being unless we, at the same time, to the same extent, and for the same reasons, respect theirs.

In contrast, the theory of free trade is concerned only with commerce. Like classical economics, it has no respect for persons, except possibly as consumers. It sees no need for government beyond minimal police protection. As was demonstrated in Seattle, the World Trade Organization is not prepared even to consider questions concerning human rights, labor rights, the environment, or the use of natural resources. Even after the financial debacle of Southeast Asia, no attempt will be made to rationalize the surge and countersurge of money around the globe. In a free trade world, politics stops at the cash register.

Before we pursue policies that deny citizens the right to make a particular contribution to the common wealth, we have a duty to guarantee that they have an actual opportunity to make a contribution in another way. This duty is not satisfied by colorful references to sunset industries or to hoped- for results from research and development that somebody may be undertaking at some unspecified time. This duty is not satisfied by vague programs, even if well-funded (and they seldom are), to retrain people for new jobs that do not yet exist. This duty can be satisfied only with alternatives that are specific, real, and at least equivalent.

And time is of the essence. Since such alternatives are exceedingly unlikely-at least no one has bothered to name one-we have a duty to protect our fellow citizens by regulating our participation in foreign trade, even if it means forgoing an extra sports shirt or a better sports car.

By exploiting their cheap labor to produce things for export to the developed nations, the developing nations condemn themselves to a neocolonial status. By encouraging this sort of exploitation, the developed nations condemn themselves to the stagnation and decline that has been the fate of all imperialisms the world has yet seen.

The New Leader

[1] Ed: the author isn’t here to ask which article he refers to but this seems correct.

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PROBABLY at least once in every one of the 18 years I’ve been writing this column, I have made fun of an obiter dictum[1] of President Calvin Coolidge: “When many people are out of work, unemployment results.” I think it is still good for a laugh, although of course it is undeniably true, and so is my variant: When many people raise prices, inflation results.

I’ll go a step further: It is only when many people raise prices that we (including the Federal Reserve Board) know we have inflation. And I’ll take another small step for man but a momentous step for understanding the economy: Except in time of war or disaster, we have inflation only when the central bank (the Federal Reserve Board) brings it about.

If you (as an individual or a corporation) plan to start anew business, or to expand an old one, or to merely keep an old one going, the first thing you have to do is look for financing. As Iago said, put money in thy purse.

You can get money in lots of ways. You can borrow it from a bank or from a venture fund. You can sell shares or unneeded assets to a more venturesome fund or to a friend or on an exchange. You can use money you have on hand or your company has on hand. It does not make much difference how you finance your enterprise, but you have to do it, and it will cost you. Even money that you or the company may have on hand has an opportunity cost-that is, what you might have made if you had invested it in some other way.

In short, borrowing comes first and its price depends on the interest rate. Interest rates have to be set before the financing of any good or service is agreed to; financing precedes manufacturing; manufacturing precedes delivery to customers; delivery requires prices, which must be set to cover all the previous costs, plus, it is hoped, a profit. This is the way capitalist business runs, and there is no better way to run it.

To be sure, different companies follow different routines to achieve the same result. Many arrange a line of credit with a bank to prepare for the needs of a year or a season or a project. Special projects may be planned all at once. An automobile company may glimpse a chance for a new sports utility maxivan. All that exists at the beginning is a price range, a schedule of standard specifications, and a menu of desired special features. The engineering and design departments see what they can do; the sales department does market research; but the car is not built unless the finance department can be reasonably sure of necessary monetary support at a feasible interest rate.

That is not to say that finance is more important than (or even as important as) engineering or design or advertising or sales. It is simply to say that finance is primary. After all, the name of our system is finance capitalism.

I have been belaboring the obvious because it is essential for understanding one of the crucial problems of our time-the relation of the interest rate to the price level in a modem economy. The interest rate has an effect on prices, because it is a cost, and costs have to be covered by prices. The causation goes only from interest rate to prices, not vice versa. Prices may affect the sensibilities of the Federal Reserve’s governors, and they do in fact set the interest rate. Nevertheless, this is not a chicken-and-egg question.

A chicken makes an egg, and the egg makes a chicken, and that chicken makes an egg, and so on. Leaving aside the Reserve’s sensibilities, prices do not affect the interest rate, because the interest rate is set before prices are.

It is possible to assemble the statistics and plot curves showing the fluctuations of the interest rate and the price level. Depending on where you start, the peaks and valleys of one will necessarily follow those of the other with, as they say, a lag. If you then start with the other one, their roles will be reversed, and the lag will be different. There is absolutely no way of telling from the statistics or the graphs themselves which “really” comes first, the interest rate or the price level.

In this, the question is like that of the three-way colonial trade (guns and calico for slaves, slaves for cotton and rum; cotton and rum for guns and calico). These are not statistical problems; they are analytical problems. We know from our analysis that the interest rate affects prices, but there is no way for prices to affect the interest rate.

Well, I’ll take that, or a little of it, back. Banks and other lenders have to make ends meet, too; so their prices (the interest rates) have to be high enough to cover their labor, capital and rent costs. But the basic price of their product is set by the Federal Reserve Board. Their overheads merely account for the differences between the rates of your friendly neighborhood banker and those of the snobbish bank in the next town. The dictum stands: Interest rates affect prices, but the Reserve, not prices, affects interest rates.

The business press frequently writes that in certain situations (usually good news, like increasing employment and more prosperous businesses) the Reserve “will have to raise rates,” but there is no natural law or legal requirement that forces it to take the specified action. If the Reserve does raise rates, it is because of the governors’ own free will, guided by their own economic theory, which in this case happens to be fallacious.

PLEASE NOTE that it does not matter whether inflation is thought to be demand-pull or cost-push. A strong argument can be made that in a modem economy inflation, when it occurs, is practically always cost-push. For demand-pull inflation to work, supply has to be rigidly limited, and in a modem economy there is practically nothing that cannot be readily and indefinitely replicated within a reasonable span of time.

In other words, while the hallowed law of supply and demand was plausible enough in the isolated market towns of Adam Smith‘s day, it no longer is absolute —except in the narrow confines of Wall Street, where the supply of investment grade securities is strictly limited. Even international cartels controlling natural resources, such as the Organization of Petroleum Exporting Countries, are of bounded effectiveness because of the development of substitutes and the threat of military reprisal.

To be sure, the Federal Reserve worries publicly about the supply of labor, and that is certainly at least biologically limited, although relaxed immigration laws could provide short-run solutions and expanded education could extend the long run. Yet the experience of the last few years should have taught us that neither the wisest statesmen nor the most erudite economists have the faintest idea where or whether there actually is a natural rate of unemployment (that most barbarous notion), beyond which inflation must rage uncontrolled.

However all this may be, the fact remains that the interest rate must be agreed to by each enterprise before the enterprise is able to make a responsible attempt at setting its own prices. Thus the price level, an aggregation of all the prices in the economy, is systematically subsequent to the interest rate. Following the money, we see that when the interest rate goes up so does the price level.

No precise formula guides the process. Some entrepreneurs will hold their prices down and be satisfied with a lower profit. Some will manage to cut other costs technological, administrative, sales, advertising, and so on. In general, though, even a small interest hike will result in a noticeable hike in the price level.

In any case, the country is full of inflation hawks-and that includes many governors of the Federal Reserve Board -who are constantly on the lookout for the most obscure forecast of the inflation they fear. Recently they raised the rate, and they threaten to raise it further, despite their admission that there is no significant evidence of coming inflation. Instead, there is much talk of pre-emptive strikes, and of the importance of being ahead of the curve. Indeed, it is widely said that the Reserve must act now.

What happens in these circumstances? The price level inches up, and actual inflation shows itself. The hawks demand a further interest rate increase. The scene is like Zeno’s paradox of Achilles and the tortoise, except that the Achilles of the interest rate can’t catch up with the tortoise of inflation, because Achilles is carrying the tortoise and even pushing it out ahead of him.

Well, we’ve seen how the story ends. In fact, we’ve seen the ending nine times since World War II. Raising the interest rate can only slow down inflation if the Reserve keeps raising it until the whole economy is put into reverse-until, that is, millions of men and women lose their jobs, hundreds of thousands of businesses go bankrupt, and public works languish.

We’re on our way. If we keep it up, we must have a recession. When former Federal Reserve Chairman Paul A. Volcker was asked if his policies might lead to recession, he replied, “Yes, and the sooner the better.” He showed how it was done. Why do we have to do it again?

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THE NEW Congressional committee created ostensibly to reach a nonpartisan solution to the Social Security “crisis” may not really be intended to do anything, except perhaps issue a report calling for further study of the problem. In fact, I think it is probably a device for changing the subject whenever some humorless member of Congress tries to make an “issue” out of Social Security. “We must wait until the committee reports,” will be the ready response. If I’m right, Social Security will be effectively eliminated from the front lines of the November general election campaign, and no one will have to take a possibly unpopular stand either for or against any of the myriad “reform” schemes lurking on the horizon.

My junior high school civics teacher would be saddened to hear of my lapse from her innocent teaching, but I, for one, am enthusiastically in favor of another do-nothing committee on Social Security. A little over a year ago the much larger National Commission on Retirement Policy, made up of presumed experts business leaders, academics, Congressmen- managed to split three ways on which reform should be endorsed; so nothing was done. That was fine, because all of them would have gotten Social Security mixed up with the stock market in one way or another. Since the stock market is still dangerous, our need for a do-nothing committee is still great.

Nevertheless, I have not forgotten all I learned in those dear, departed civics classes, where we were taught to analyze legislation under three headings: (1) the need for the law, (2) the constitutionality of the law, and (3) the proper taxation to pay for it. That continues to strike me as a good, systematic approach, and I hereby suggest that the committee spend its time looking at the existing Social Security Act accordingly. This will give it something to do that no prior committee has done and keep the matter bottled up until after the balloting. Let me demonstrate.

1. Why was the Social Security Act needed? Well, there was a jim-dandy depression on. There being no official or semi-official definition of “depression,” one has to be supplied: A depression is a massive, comprehensive and persisting breakdown of the economic system. The economy does not recover without major changes or a major shock or both.

In the 1930s, millions and millions of people were out of work; the municipal poorhouses and charity soup kitchens were overwhelmed; beggars were everywhere; bands of hobos hitched long journeys on freight trains, tracking the seasons or wandering aimlessly. In most towns, near the freight yards or in the gashouse district, there appeared “Hoovervilles” of shacks made from old cartons and discarded (or stolen) boards, furnished with broken furniture from the town dump. In many cities a portion of the local jail was used as a temporary shelter for the more respectable homeless. I myself spent a night as a guest of the Hudson, New York, jail in the course of a hitchhiking journey to search for a job that I didn’t find.

The Great Depression was not a pretty time. Millions suffered, despite having worked long and hard and faithfully. Their dependents, of course, suffered along with them. So did young people coming fresh to a labor market that had no place for them. The society had failed, not a particular individual or group or class. Thus the Social Security Act was needed to deal with at least one aspect of the collapse of the social system-namely its effects on the elderly, the disabled and the orphaned.

2. Was the act constitutional? That proved to be a tough question for a Congress dominated by Southern Dixiecrats and Northern Republicans, and for a Supreme Court possessed of states’ rights notions that had become obsolete at Appomattox Court House on April 9, 1865. It took six years of depression for Congress and the Supreme Court to follow the election returns and take the general welfare seriously. Follow they eventually did, and our second question was answered in the affirmative.

3. Is the taxation appropriate? That question is still with us. The dispute today concerns the adequacy of the present payroll tax. No one wants to increase the rate. Some want to increase the income by putting a portion of the money in the stock market; others argue that income will be more than sufficient as long as the economy remains robust. The real trouble, however, is in the method of taxation itself.

A payroll tax has nothing going for it. It is comparatively easy to evade, especially by those in domestic or casual work. It also discourages employment. If you have a job, that laudable fact triggers a tax on you or your employer or both. On the other hand, if you are a professional gambler, or if all you do for a living is clip coupons and play the market, you don’t pay any payroll tax.

To be sure, aid for the needy is a responsibility of the state; and all businesses-manufacturing, wholesale or retail –owe their existence to the state. In some cases the state licenses or charters or franchises them; and in every case the state protects the society that is the source both of their work force and their market. Consequently, it is reasonable for businesses to be taxed to help pay for the general welfare of the government that nourishes them.

But a payroll tax is a poor way to do it. It is an up-front cost that must be met with the first employee hired, that increases with each additional employee and each wage increase given, and that continues until the last hour of the last employee’s employment. In his book The Next Left, the late Michael Harrington argued that French President Francois Mitterrand‘s bold, popular and promising social policies resulted in economic stagnation because he financed them by levying payroll tax after payroll tax. Instead of expanding, French industries cut employment to the bone in a largely vain attempt to keep their prices competitive with those of neighboring countries. The failure of Mitterrand’s programs had nothing to do with the fact that he was a Socialist. Their effect would have been the same even if the programs had been private fringe benefits.

OUR Social Security system, although in many respects the most successful legacy of the New Deal, has twice the vices of an ordinary payroll tax, since both employee and employer are taxed. Wage negotiations are rendered more difficult because the employees’ present value of any wage is reduced by the 6.2 per cent Social Security tax plus the 1.45 per cent Medicare tax, while for employers labor costs are increased by the same 7.65 per cent (called, no doubt to spare their delicate sensibilities, a “contribution”).

In addition, the Social Security tax has the extraordinary effect of being a radically regressive tax on the nation’s workers, especially the working poor. It is, to begin with, a flat tax–even flatter (as far as it goes) than the various flat tax proposals of current Republican politicians. It has no exemptions or credits, and starts with the first penny a worker earns. It continues at 7.65 per cent on both employee and employer until the employee earns $72,600, whereupon only the Medicare portion remains. A Fortune 500 CEO who pulls down $10 million a year therefore pays a rate that is less than one ten-thousandth of the rate paid by the charwoman whose job it is to clean up after him.

Nor are these the only indefensible unfairnesses of the Social Security tax. More important in the long run is the fact that the tax has been used to eliminate the higher brackets of the personal and corporate income taxes, and hence exacerbates the widening gap between the rich and the poor in the United States.

The Social Security system is said to be a pay-as-you-go plan, but of course it isn’t. It is a pay-years-before you go plan. The Trust Fund that is being paid for now will not be used up before 2029, and probably much later, if ever. In next year’s budget, the total of employee taxes, employer contributions, and interest earned by the Trust Fund is $636.5 billion, while the entire cost of Social Security (beneficiaries, bureaucrats and all) is only $408.6 billion. The $227.9 billion Social Security surplus not only goes to make possible the budget balance everyone is so proud of, but also accounts for the entire budget surplus that Congress is squabbling about.

The trouble with Social Security; in short, is the method of meeting the costs. A payroll tax is adverse to national employment and investment, and is unreasonable in its incidence. Moreover, the present payroll tax may be incapable of paying the bills. It is anticipation of the last that has caused today’s uproar. But speculating on the stock exchange, whatever else may be said for or against it, is almost guaranteed to fail at the most critical moment. A booming stock market does not guarantee a booming economy, but a crashing market is sure to bring the economy down with it.

Again I can offer a personal reminiscence. My father put together a satisfactory nest egg by playing the boom market of the 1920s. When the ’30s began he believed President Herbert Hoover and did not “sell America short.” In August 1933 he died broke. As the HMO lobby’s ads say, “There must be a better way.” And there is: The Social Security Act addresses a national need and it should be funded by a national tax. The income tax does not inhibit employment and investment, because it falls only on persons and enterprises capable of sustaining employment and investment.

It is often argued that the income tax is too subject to the cold and shifting winds of politics to be the support for something as vital as Social Security. But the raucous history of the present debate has surely demonstrated that Social Security is in any event buffeted by the very same winds as the rest of our political life.

The New Leader

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MANY YEARS AGO, when I was a college undergraduate, there was some talk on campus about The Fountainhead[1], a massive novel by Ayn Rand. I was aware of it because one of my close friends told me a bit about it, and the older brother of a classmate had edited it, but I never read the book nor did I see the movie. Perhaps it was too huge for me (I was reading Ernest Hemingway‘s stories and Gertrude Stein‘s scribblings). Perhaps I was sufficiently law-abiding to be put off by the novel’s intensely self-centered architect hero[2], whose action at the end was the principal topic of what I heard (he destroyed an allegedly supremely beautiful building he had built because the owner wanted some changes).

I never read Atlas Shruggedeither, or any of the other works by Ayn Rand, and I was not aware that she was a self- invented economist until I became one myself. Even then I was-and still am-put off by the name she gave to her philosophy (“objectivism“). But despite my ignorance of what she has written, I am prepared to claim that she has had a great and salutary effect on the present and possible prosperity of the United States of America. Maybe of the world.

One of Ayn Rand’s disciples was Alan Greenspan, who grew up to be Chairman of the Federal Reserve Board. So far as I know, Greenspan has never made a public reference to her, and so far as I am aware, only three of her doctrines may have slipped into the proceedings of the august body he heads. He has spoken some odd words on the movement of the price of gold as an indicator of the future course of the price level. His aversion to regulation of the rogue multitrillion-dollar derivatives market may be linked in his mind with the behavior of the hero of The Fountainhead. And almost alone among the public men of our time, he doesn’t believe in the barbarous theory of a natural rate of unemployment.

In any case, I suspect that her influence has been both more profound and more beneficial than her ideas. As a result of his association with her, Greenspan learned how to be at once the consummate insider and the consummate outsider.

Because he is a consummate insider, he got to where he is. Because he is a consummate outsider, he has not been overawed by the high-powered bankers and economists with whom he does business. Because he is not overawed by these worthies, we have not had a boost in the interest rate since March 1994, and in fact had three quarter-of-a -point cuts last summer and fall.

These 60-odd months without a rate increase constitute the longest, indeed the only, period of tranquility the Federal Reserve Board has allowed the American economy in the 30 years since the Reserve launched its all-out war against inflation-which propelled the Consumer Price Index from 36.7 in 1969 to 99.6 in 1984, a record-breaking and stupefying leap of 272 per cent in 14 years. It is for the present period of tranquility (and for its continuance, if he can bring it off) that Greenspan is renowned today and will be forever famous in the annals of economics and of political economy.

There is no doubt that if Greenspan had polled the economics profession and the banking profession he would have had them almost solidly against him. On July 19, 1995, Greenspan said in Congressional testimony, “I don’t believe that any particular unemployment rate-that 5 per cent or 5.5 per cent or whatever numbers we’re dealing with-is something desirable in and of itself. I don’t believe that.”

Neither the New York Times nor the Wall Street Journal reported this testimony (but THE NEW LEADER did, and I have the videotape). As I said at the time, this was earthshaking testimony. It directly contradicted what then was the first or second most sacred economic law, namely the natural rate of unemployment, a.k.a. the nonaccelerating inflation rate of unemployment, a.k.a. NAIRU. It is possible, but not certain, that the ancient “law” of supply and demand had a tighter grip than NAIRU on the hearts and minds of economists and those who pretended to an interest in economics. Yet Greenspan contradicted this barbarous doctrine, and got away with it.

As it happened, the economy jogged along pretty well. The stock market boomed, because the Baby Boomers were worried about saving for retirement and didn’t know where else to put their money. As the market soared, more and more of them made nice killings and began to spend some of their capital gains. Retail sales, especially of automobiles and other big-ticket items, picked up. Unemployment began to fall, and so, to almost everyone’s surprise, did inflation.

After a while the media began looking for someone to give the credit to. President Clinton was willing, but no matter what he claimed, and no matter what photo ops were arranged, people kept saying that he was too preoccupied with impeachment to run the country. Perhaps they were right, and, obviously the Republicans were too preoccupied, for the same reason.

Greenspan was available, and an interview with him was almost as good copy as the stories quoting Casey Stengel used to be. He talked about the free market, so he became the leader of the free world.

Of course, I wasn’t there, but I have a clear picture of what happened next. At meeting after meeting, the Federal Reserve Board staffers brought in sheaves of disturbing figures showing that Wendy’s in Sandusky was having trouble holding dishwashers and hiring cashiers; that Kmart in New Jersey had constant openings for stock clerks; that Boeing in Seattle was looking for riveters. Everywhere, in other words, the unemployment rate was falling-falling steadily below the rate at which all the bankers in the country knew, and all the mainline economists in the country absolutely knew, that inflation definitely had to break out again. The financial press talked nervously of the importance of being ahead of the curve, and Greenspan himself spoke of making a pre-emptive strike against inflation.

Nevertheless, Greenspan has not acted. He tried jawboning the stock market-and quickly learned that his reputation as economic wise man of the Western World was in jeopardy because practically no one was in favor of repeating the 1987 market crash.

Lately he has made a series of speeches suggesting that an increase in the productivity index explains our “miraculous” combination of falling unemployment and falling inflation. Since the productivity index is a fraction (output divided by hours worked), its value rises when the denominator falls. Greater productivity, therefore, is hardly an explanation of increasing employment.

WELL, maybe Greenspan can pull it off, but it would help if he could make clear why NAIRU has not performed as advertised. Since the business and financial press has not been able to do that either, the professional belief in NAIRU has been muted but not stilled. The true believers are prepared to stay the course, because they have been given no reason not to.

We shall continue to live in fear that our tranquil days of steadily expanding prosperity will soon be over unless somebody sets them straight. So, it might as well be me, here and now.

It isn’t enough to remind the believers that not so long ago they insisted the telltale rate of unemployment was 7.0 per cent, then 6.5 per cent, then 6.0 per cent, then 5.5 per cent, then 5.0 per cent, then 4.5 per cent, and now it must be 4.0 per cent or lower. They shrug off this embarrassment with the complaint that the available statistics are imperfect or that, as Humphrey Bogart said when told there were no waters in Casablanca, they were misinformed.

It also is not enough to show them that every one of the nine recessions since World War II has been preceded by boosts in the interest rate. The boosts were said to be necessary to nip inflation in the bud. But in fact inflation accelerated more rapidly after the boosts than before them. Another fact: In all the years since World War II, no matter what the Federal Reserve Board has tried, the price level has fallen only once, and in that year (1955) the interest rate fell too. Again, of course, the statistics are imperfect. And without a coherent theory everything is anecdotal, the diehards argue, as the doctors did when Linus Pauling tried to tell them about Vitamin C.

Yet the reason NAIRU is nonsense is not far to seek. To begin with, the interest rate and the unemployment rate are both percentages, just as apples and oranges are both fruits. Interest is a direct cost or an opportunity cost on both sides of every economic transaction. Labor costs are similarly universal. But interest costs are closely uniform for comparable risks throughout the economy; labor costs vary widely from industry to industry, job to job, locality to locality, and (shamefully) from ethnic group to ethnic group as well as from gender to gender.

The two percentages are so radically different in composition that NAIRU theorists themselves never had a theory of their interaction. All they had were some empirical observations that occasionally made pretty graphs, like the Phillips curve. As with all empirical observations, though, theirs were liable to falsification by events.

The serious recessions of 1974-75 and 1980-82 were certainly falsification enough. But those events were disregarded, perhaps because practitioners of this dismal science tend to believe that dismal outcomes must be true, while relatively happy outcomes (like the present situation) must nurture some occult seeds of their own distraction.

Moreover, a 1 point fall in the unemployment rate causes little more than a 1 point rise in the national wage bill (which itself is only three-fifths of the costs of production), whereas a 1 point rise in the basic interest rate (now 4.75 per cent) eventually results in a drop of about 20 per cent in the purchasing power of money (which is, of course, equivalent to a 20 per cent rise of the price level, or a pretty stiff dose of inflation).

Far more important, the interest hike would produce a 16.7 per cent decline in the borrowing power of money, resulting, as we shall see, in a 33 per cent drop in the value of investments that must be made to keep the capitalist system going. If the interest rate is 5 per cent, $500 will get you a year’s use of $10,000. You can invest that $10,000 in an enterprise of your choice, and, unless you are unwise or unlucky, you will earn back your $500 interest plus a profit to boot and be ready to do more of the same.

But if the rate rises to 6 per cent, you will be able to borrow only $8,333 with your $500. Worse yet, the purchasing power of the $8,333 you borrow will have been reduced 20 per cent; so in the end you will have only $6,667 worth of goods to invest in, compared with the $10,000 worth you would have had before the interest hike.

Any way you look at it, the “punishment” of a 1 per cent increase in the interest rate does not fit the “crime” of a 1 per cent decrease in the unemployment rate.

For the characteristic economics essay or book lays out-“Like a patient etherized upon a table”-an account of the economy, or some part of it, demonstrating how it works, or doesn’t work. Often the putative truths contained therein are unpleasant, like the iron law of wages in the 19th century or the natural rate of unemployment in the 20th. Nonprofessionals are frequently prompted to ask, not “What is it?” but the truly overwhelming question, “What should we do about it?” Professional economists have tended to brush that question aside. They are, they say, scientists, not humanists; and science concerns what is, not what ought to be.

But there is another reason for the posture of most economists, and that is the problem posed by the first sentence of the last chapter of John Maynard Keynes‘ General Theory of Employment, Interest and Money: “The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and income.” One would have to be extraordinarily deficient in empathy for one’s fellow human beings not to recognize the justice and urgency of Keynes’ dictum. One would also have to be exceptionally ignorant of the ways of the world to imagine that the problem will simply solve itself. Indeed, anyone with empathy and knowledge must find it acutely uncomfortable to deny that confronting those “faults” is the special responsibility of economists.

All those I have named are honorable men, as I believe almost every economist to be. I am sure none would dispute the truth of Keynes’ pronouncement. Faced with the enormity of the problem, though, all, with the possible exception of Marx, have found in pseudoscience an excuse for denying the need or ability to do anything substantial, and hence for refusing their responsibility.

The first thing to note about the problem is that originally it was a double pronged affair, but by now the prongs have joined together. In the ancient world, the feudal world and the mercantilist world, you could have full employment along with unconscionable disparities of wealth and income. Perhaps even in Keynes’ day, over half a century ago, it was possible to consider the two great failures of the economy separately. Today, however, we shall not be able to solve unemployment without at the same time solving maldistribution.

An explanation for the intertwining of the two problems was suggested by Joseph A. Schumpeter in an observation of the sort he made so casually and so tellingly. “The capitalist achievement,” he wrote, “does not typically consist in providing more silk stockings for queens but in bringing them within the reach of factory girls in return for steadily decreasing amounts of effort.” The modem economy, unfortunately, may not be quite so good to factory girls as Schumpeter suggests.

The reason lies with the opportunities the wealthy have to dispose of their income. In most cases, their money derives from mass production, but they do not spend much of it on the products of the assembly line. This is not merely a matter of taste. It would be flatly impossible to do so. You can buy a top-of-the-line Mercedes, the archetypal expensive, mass-produced commodity, for about $145,000. If you were a senior officer of a Fortune 500 corporation, or a partner in a major financial house, you could pay cash for a brand-new Mercedes the first of every month, junk it at the end of the month, and still have more money than you and your family could conveniently spend.

Traditionally the wealthy have invested their surplus, a practice generally considered to return it to the producing economy it came from. And, like Prufrock’s Yankee contemporary, Miniver Cheevy, they think they “have reasons” to believe they are doing something good. Theoretically, for example, their investment would make more silk stockings available at lower prices by increasing productivity. But in common with the romantic notions Cheevy holds so dear, the idea is largely spurious.

This is because, regardless of what distinguished economists say, the producing economy is, in general, overcapitalized. As things stand, it could very easily, without investment in another machine or machine tool, increase its output by 15 or 20 per cent. It has that capacity right now. More investment will not lead to greater productivity.

Increased demand would. But Chairman Greenspan still hopes to restrain the “exuberance” of the stock market-in which case its upper middle class “wealth effect” will disappear. And far from trying to stimulate consumption, credit card companies can’t wait to put fear of a new bankruptcy law into their lower-middleclass clients.

These actions reduce the nonwealthy to relying on what they earn by working, and what they earn necessarily falls short of being able to buy what industry produces: Schumpeter’s silk stockings (or their millennial equivalent) become less affordable. The shortfall is equal to the earnings and other withdrawals of the wealthy. Its correction must also come from that source.

LEFT TO THEIR own devices, how do the wealthy spend their money? After buying several Andy Warhols and subscribing to tables at a couple of dozen charity balls, it is all too easy to become frustrated by the attempt to consume one’s income and turn to speculation. So the money the wealthy take out of mass production industry stays out, and the money devoted to speculation becomes a flood.

A “moderate” session of the New York Stock Exchange today sees half again as many shares traded as were thrown on the market in the frenzy of the crash of October 1987. And still there is not enough to meet the demand. Besides the NASDAQ and the Amex and the mercantile exchanges and exchanges abroad (including way stations all over the new global village), there are $85 trillion worth of derivative “products” invented by clever bankers and brokers to facilitate betting on almost anything you can think of. In comparison, numbers running is child’s play.

Also in comparison, trying to make money by operating an enterprise that turns out actual goods and services is a mug’s game. As fortunes are made in speculation, the opportunity cost of productive enterprise rises. To keep those who have invested in industry from selling out, they have to be promised increased profits; and the fashionable way of doing that is for lean and mean companies to become leaner and meaner, thereby narrowing the already narrow market. Where once there was a spreading wage-price spiral, heading upward, the economy has slipped into a constricting lean-mean spiral, heading downward.

The wealthy are not the only ones contributing to this trend. The middle class is the beneficial owner, through what are called “institutions” (especially mutual funds and pension funds and insurance policies), of between one-third and one half of all the shares on the current exchanges. By being funded rather than treated as current expenses, these institutions soak up purchasing power and weaken aggregate demand. The funds’ speculating deprives the producing economy of efficient financing. The resulting shrinkage of the producing economy raises the rate of unemployment, accelerating the erosion of the middle class the institutions were created to protect, and exacerbating the polarization of society.

That is how we are approaching the turn of another century: The nonwealthy are unable to buy the products their industry can produce; industry consequently has fewer opportunities for expansion; the wealthy consequently have fewer opportunities for productive investment; the nonwealthy consequently have fewer job opportunities and more of them become unemployed (“naturally”).

It is easy to convince yourself that looking to the government to fix the situation is hopeless. President Franklin D. Roosevelt couldn’t get a cap on stay-at home incomes even in the midst of World War II, when millions of young men and women (and middle-aged ones, too) were risking their lives for their country. President Richard M. Nixon, despite being re-elected by the second largest percentage of the popular vote yet recorded, couldn’t enlist a Congressional majority for a negative income tax. The current tax law, whose top rate is less than half the top rate of 25 years ago, does not assess even the present top rate against capital gains. And who can imagine the Federal Reserve Board maintaining an interest rate that is either low or steady, let alone both?

Some (if not all) of these things should be done to mitigate the polarization of our society. If they can’t be done in the current political climate, what can economists be expected to do about it? Well, if economists can’t suggest answers, the least they can do is get out of the way. Certainly no solution will succeed if no one has the will to work for it, and certainly those most responsible are the people claiming professional status.

In the meantime, the outstanding “faults” of our economic society, albeit forged into one, are substantially identical with those of Keynes’ day. But the degradation, despair, and (in the words of the late Erik Erikson) negative identity are worse. Will human voices wake us before we drown?

The New Leader

[1] Ed. Well, I’ll be damned. The author, uncharacteristically, has the quote wrong. Eliot wrote of “streets”, not “songs” that follow like a tedious argument ….